Beware the 'perfect storm of negative events' one expert says will send stocks crashing
- Optimism is creeping back into the stock market amid expectations of trade-war progress, and as analysts across Wall Street prime investors for strong second-half earnings.
- Vincent Deluard, a macro strategist at INTL FCStone, says investors should avoid being swept up in what could be a strong summer, and instead focus on a troubling combination of factors that could wreak havoc in the fall.
- He outlines four main headwinds that could strike the market simultaneously.
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The INTL FCStone macro strategist is staunchly negative on the equity market in the medium term, even if that means his bear forecast has to weather more share gains over the next few months.
Deluard says one way stocks could deliver a bullish fake-out is if the US and China continue their game of chicken around trade. He thinks the posturing could deliver just enough good news to keep stocks climbing, backstopped by a reluctance from both sides to escalate matters much further.
And that's just part of it.
"Rate cuts, a fairly resilient economy, high earnings beat rate, and the recent pullback of valuations will convince some investors to buy the dip," Deluard said in a recent client note. "Good for them."
If Deluard sounds bemused by the entire situation, that's because he is. He's focused on the longer term - a future he sees filled with an unfortunate amalgamation of negative factors.
"Stock market declines will resume in the fall, with a perfect storm of negative events," he said.
So what exactly can stock investors expect to contend with in the fall of 2019? Allow Deluard to outline four main headwinds.
(1) An earnings growth "reality check"
Deluard argues that analysts are setting investors up for disappointment with their expectations for a sharp earnings-growth rebound. He doesn't see this happening, so long as the US-China trade war stays rife with new tariffs.
"If margins fail to expand, companies will need to give much lower guidance as they report second quarter earnings in the summer and/or disappoint analysts in the third and fourth quarter," he said.
As past instances of downward revisions are any indication, the stock prices of the companies involved could take a swift beating.
(2) A buyback blackout
After a company reports earnings, they're prohibited from buying back shares in what's known as a "blackout" period. Deluard notes that one of these spans is set to fall in the first couple weeks of October, after a majority of companies have reported.
Deluard has previously harped on the fact that a slowdown in buyback activity would deprive the equity market of its most reliable backstop. Combine that with the fading influence of President Donald Trump's tax plan, and you have a recipe for disaster.
(3) A disappointing Federal Reserve rate-cut schedule
The market is hoping for three rate cuts before year-end. Deluard thinks they'll get two, tops.
That's because he doesn't expect inflation to cooperate and stay low throughout the easing process.
"Inflation (or rather deflation) expectations may have gotten ahead of themselves," Deluard said. "Broad-based indicators, such as wage growth or the New York Fed's underlying inflation gauge have not slowed significantly."
He added: "It will be hard to justify in third cut in the fall if inflation and the economy has not slowed down."
It's safe to say that if the Fed fails to deliver, the market will do what it always does in this situation: throw a fit and sell off.
(4) A likely escalation of European political risk
When it comes to European politics, Deluard says pick your poison. He thinks all of these issues could come to a head around the same time:
- European Commission action against Italy's "excessive" deficit
- Mario Draghi's term as European Central Bank president will expire on Oct. 31, which could increase the "risk of miscommunication"
- As the Brexit deadline approaches, the fact that it'll likely be spearheaded by someone supporting the "no-deal" platform complicates matters even further
"Brace for some late-night fun at European summits," Deluard said.